If you are considering the sale or purchase of a business, you are likely interested in the equity value of the business. Equity value is often thought of as market capitalization, but the two terms treat shareholder loans differently, and need specific clarification to understand the difference.
Equity value is the total value of shares in a company. To calculate equity value, you determine the enterprise value – the cost of the business, including debt and cash. From that figure, you deduct the debt and cash. What you have left is the equity value – the final figure that is available to equity investors.
Another simple method of computing the equity value of a company is to multiply the share price of the business by the number of outstanding (or available) shares.
Equity value is important when considering the value of a company, but should be taken into consideration along with enterprise value when a company is being considered for purchase. The overall picture of enterprise value gives a much more realistic idea of the value of a company.
To help understand the difference, consider the sale of a home. The sale price of a home is the enterprise value – the market value that a consumer was willing to pay. Deducting the mortgage amount, or the debt of the home, gives you the equity value – the amount of money that the seller would walk away from the sale with.
Identifying equity value can give you an idea of the investor’s value in the company, but does not take into account the complete financial picture of the company. It is easy to get caught up in the numbers on an accountant’s report and still miss the overall picture. Using equity value as one tool of valuation is helpful, but should not be the determining factor of a company’s worth.
Be sure, you first understanding the general accounting principles before focusing on equity value.